A legal loophole used by hundreds of entrepreneurs to avoid paying a higher capital gains tax rate this year is set to be hit by the economic downturn.

According to a report in the Financial Times,when the Government said that it would increase the base rate of capital gains tax for many people from 10 per cent to 18 per cent in April, it triggered a frenzy of company sales as owners tried to avoid paying the higher rate.

For those who were unable to sell their companies before the April 5 deadline, accountants came up with a loophole that allowed them to crystallise the old 10 per cent rate before a sale was completed.

The move involved entrepreneurs signing unconditional sale agreements with another party, in many cases a trust, which would complete only once a third-party buyer was found. This ensured that the owner of the company would pay only 10 per cent on the gains even if selling after April 5.

But the economic downturn has made it much harder for companies to find buyers at an acceptable price, increasing the chances that many will be left facing a "Catch 22", say accountants.

The FT reports that those businesses that fail to sell will still have to pay a tax bill, due on January 31 next year, for 10 per cent of their capital gains but without the proceeds from a sale to pay it.

In some cases, company owners may be tempted to tear up their initial sale agreement to avoid the tax bill. However, accountants say that this may not work and that they will in any case lose the stamp duty and fees that have already been paid on the sale.